**Fung-Hsieh 7 Factor Model**

The **Fung-Hsieh 7 factor model** is a risk factor model commonly used to evaluate hedge funds’ performance. The seven factors are risk factors that explain a large proportion of the returns of hedge funds. The model was proposed door David Hsieh and William Fung in 2001 in a paper titled Hedge Fund Benchmarks: A Risk-Based Approach”. The aim of the factors is to capture the returns to a well-diversified portfolio of hedge funds.

On this page, we discuss the Fung-Hsieh 7 factor model definition. In particular, we discuss the risk factors that are included in the model. We also briefly introduce the **Fung-Hsieh 8 factor model**.

**Fung-Hsieh 7 factor model definition**

The 7 factor model for hedge funds is actually a simple linear factor model, similar to the Fama and French 3 factor model for individual stocks. In this case, however, the model is used to explain hedge fund returns.

The model uses the following **7 factors**:

- Bond Trend-Following Factor
- Currency Trend-Following Factor
- Commodity Trend-Following Factor
- Equity Market Factor
- The Equity Size Spread Factor
- The Bond Market Factor
- The Bond Size Spread Factor

The first three factors are trend-following factors proposed by Fung and Hsieh in a different paper called “*The Risk in Hedge Fund Strategies: Theory and Evidence from Trend Followers*“. These factors are available here.

Next, the** equity market factor** is captured using the S&P 500, the **size factor** is the difference between the Russell 2000 index monthly total return – Standard & Poor’s 500 monthly total return. The **bond market factor** is proxied using the the monthly change in the 10-year treasury constant maturity yield Finally, the **size spread factor** is measured using the monthly change in the Moody’s Baa yield less 10-year treasury constant maturity yield (month end-to-month end).

**Fung-Hsieh 7 factor model formula**

Once we have the factors, the model looks as follows

where PTFS are the trend-following factors for Bonds, Currencies, and Commodities, EQ is the equity factor, ES is the Equity Size factor, BM is the bond market, and BS is the Bond Size factor.

**Fung-Hsieh 8 factor model**

A few years after the introduction of the 7 factor model, Fung and Hsieh added an eighth factor. This model is referred to as the Fung-Hsieh 8-factor model. The additional factor that is added to the model is the **MSCI Emerging Market index**.

**Summary**

We discussed the Fung-Hsieh 7 factor model. This is the workhorse model when researchers try to explain hedge funds’ return and analyze whether hedge funds generate alpha.